The rupee and the Reserve Bank of India (RBI) have amazed hedgers and speculators worldwide with its robust performance despite the moves in US dollar, global geopolitical risks and demonetisation.
Long term hedgers, especially the exporters on the sell side, have tremendously benefited due to premiums and currency appreciation.
On the current account front, the April trade deficit widened to a 29-month high (of $13.25 billion) despite strong growth in exports on a year-on-year basis.
Going forward, crude prices are likely to remain relatively stable. Demand for gold is also likely to remain muted as jewellers clear existing stocks built up in anticipation of marriage and festive season, but a rise in political risks in the United States (US) has been quite a dampener.
On the capital account front, inflows have continued into the primary and secondary markets. Though inflows into equity market were showing signs of slowing down, yield-seeking overseas investors have continued to pour money into debt.
Now, with CPI (consumer price index) likely to significantly undershoot the central bank’s comfort zone, the MPC (Monetary Policy Committee) may be compelled to tone down its hawkish stance. This may further lure overseas investors to the debt markets on account of high real rates.
India currently offers one of the highest returns in real terms among emerging markets and that is reflected in the outperformance of the Rupee.
The recent US data, meanwhile, has come in below expectations (CPI and retail sales), which could imply that the Federal Reserve would hike rates and roll back its balance sheet size in a calibrated manner.
In India, upside risks to inflation stem from below average monsoon, hike in HRA (house rent allowance) component of 7th Pay Commission and rollout of goods and services tax.
With equity markets doing well, a number of primary market issuances are in the pipeline. The government is also looking to reduce its stake in PSUs (public sector undertakings).
Rupee-denominated bonds (Masala bonds) are gaining in popularity. All this implies that inflows into capital markets could continue in the medium term.
The FPIs (foreign portfolio investors) are invested to the extent of 82 per cent of the permissible limit in central government securities and 84 per cent in corporate debt. This implies that Rs 112,000 crore ($17 billion) of limit is available for further investment in debt markets.
Looking at the bigger picture, as long as the monthly trade deficit i.e $11-13 billion is funded by inflows into equity and debt ($2-4 billion), net FDI ($2-3 billion), net inward remittances ($6-7 billion), one can expect the Rupee to be reasonably stable with an appreciating bias.
The extent to which the central bank absorbs the inflows into capital markets will significantly affect the Rupee’s performance. It may continue to intervene in spot and pay forward. This can continue to support the forwards, especially far forwards.
RBI’s forex reserves as on 5th May stood at $375.7 billion in comparison to $364.01 billion as on 03rd March. Recent price action gives the impression that the central bank has been protecting the 64 handle, therefore 63.90 would be a crucial short-term support.
On the upside, break and close above 64.72 is required for a medium-term reversal. The rally in the Rupee to a large extent has been liquidity fuelled. The reversal could be equally sudden and strong when the liquidity tide reverses or on risk aversion.
The recent Donald Trump drama and weakness in global markets could become the game changer and extremely important indicator to watch for. After all its May and historically they say “sell and run away”.
The author is CEO & Founder, IFA Global
